Why Is Apple Stock Falling Down?

If you have been following financial media over the past few weeks, you might have already heard the news that Apple stock has been falling down. In fact, a third of its stock value is gone since its peak in October.

How can this happen? Isn't Apple still the leader in technology and gadgets? Don't they still make great products and more importantly great profits? Why is the market then sending the stock down? In this post, I will deal into the the market psychology and factors that have been working against Apple over the past four months.

The total value of the company, called the marketcap, is the product of all the shares in the company multiplied by the stock price. In theory, this is the money someone needs to buy the whole company off. Apple's marketcap is currently $450 billion (even after the fall).

Investors look to see if Apple can really produce enough profits to justify the $450 billion. To arrive at the valuation, there are two dominant methods used:

1. Discounted Cash Flow method.

Here you project the company's profits into the future and then using the interest rates & risk analyze what should be the value of that stock using a standard formula. The DCF value of the stock is far more than its current value.

2. Ratio comparison method

Just like how real estate players value properties, stock investors look at the comparable in related companies. Here you take the key indicators of a companyand compare it against industry competitors. In almost every metric of comparison, Apple is ranked high.

How come Apple is going down even the valuations indicate that the stock is undervalued? There must be something more to it.

Fact 1: Valuation is always about the future

Your friend Tom comes to you and has an "irresistible" offer for you. He is selling a skyscraper in the New York to you at an unimaginable rate of $1 million. But, the catch is that the building will last only one day and will be torn down the day after. Would you still buy that building?

When an investor is buying a company, he/she is always looking to grow that investment by betting on a growing company. The future is the only thing that matters. Since the release of iPhone 5, the market has started to question the future of Apple as the world's leading innovator. Although Apple's products are still selling like hot cakes, the sales are trailing the estimates as Samsung has caught with Apple on quality and features. http://www.huffingtonpost.com/20... In 2007, iPhone was a mile ahead of its competitors. However, in 2013, there is only a sliver of difference between iPhone and its top competitors.

For this purposes, it is less important if Apple has produced the iPod and the iPhone. The only thing that is important is, what is in the making?

Technology sector is notoriously hard to predict. In the 1980s, DEC was at the top, but the brand is dead. Same with SGI that had a huge reputation in late 80s-90s but was bankrupt. Sun was taken over by Oracle and IBM had to substantially reinvent itself to stay relevant. Even in 2005, Microsoft appeared that invincible Goliath, but has now slipped below the media radar now. RIM (Blackberry maker) was the leader in early 2000s but is increasingly irrelevant. You can also add the 1990s hotshots Palm, Yahoo!, and AOL. Apple itself was close to bankruptcy in the mid 1990s.

In short, it doesn't matter how great a company's past was. In the tech sector, if you don't live in the bleeding edge, you don't live long. Tech customers have notoriously short memories and will not take long to forget the market leader of yesterday. MySpace, anyone?

Can Tim Cool continue to keep Apple in the bleeding edge?Can Apple continue to produce jaw-dropping stuff in the post-Jobs era? No one knows. CEO Cook has not yet proven himself yet.

Fact 3: Higher the bar, higher are the expectations.

For the past 10 years, Apple has been wowing its customers with ingenious products. iPad, iPhone, iPad... Customers wait in line, braving rain and snow to get their hands at Apple's products. However, the higher you grow, the bigger the expectations become.

Just as the fans of an Olympian runner will not be content with their hero finishing the 100m line in 10 seconds, the fans of a company like Apple will not be content with anything short of the best. Tech companies have found it extremely hard to keep up with such expectations. Google learned the lessons hard though the launch of Google Wave, Knol, and Google +. Market expectations keep shifting up and if you don't keep up with your own records, market will be quick to punish you.

If a company of the caliber of Apple starts slowing down in innovation, customers start doubting the company's strengths. A lot of times this can send the company into a downward spiral in a sort of self-fulfilling prophecy. It has been three years since the last major innovation, iPad. For Apple fans that is eternity.

Fact 4: Cash is a pain, if not managed well

Eating food is good, but in excess it leads to obesity.Same for every good stuff known to humanity. For Apple, the obesity is from its bulging cash reserve. Companies maintain cash reserves to pay for inventories, new factories, and as a buffer on rainy days. Tech companies keep a little more cash, as the sector is uncertain and new innovation is often expensive.

However, Apple keeps a whopping $135 billion in cash. It sounds sweet if you are a naive investors. But, if you are a shrewd investors you should question the rationale. After all, you didn't invest in a bank. Why is Apple using your investment to just save in bank deposits earning 2%? Of course, some of the cash is in overseas locations (from sales there) that can't be brought back immediately. But, the rest of the cash should be returned to the investors through dividends and buy backs. In a sort of belated recognition of this, Apple has announced some buybacks now. Apple weighs dividend boost, stock buyback to appease investors

Stock Market is the World's biggest guessing game

No one has a perfect view of the future. The stock market is the world's biggest "treasure hunt game" where all the participants collectively try to predict the future using various clues. The clues come from various news sources and investors constantly take various news to predict the future of a company. This is why you see the stocks of major companies constantly wobbling.

The stock market typically works like this:

Competitor introduces a new product. Stock down.

Economic indicator shows more customer purchase. Stock up.

Strike or fire in a major plant. Stock down.

Hired a new hot-shot executive. Stock up.

In Apple's case, plenty of recent news have turned less than ideal:

No new product announcements. Since iPad launch three years ago, Apple is yet to make a major announcement that would significantly change the paradigm. There are no major rumors for any game-changing future products from the company.

Half of Apple's profits come from the iPhone. However, the competition has caught up.Samsung Galaxy SIII is in fact ahead of Apple in features and quality. Customers are also responding positively to the bigger screen size (forcing Appleto finally change its screen size in the last release, proving the popularity of the bigger screen).

In fact, S3 is now the world's largest selling smartphone, overtaking iPhone 4S. That is a scary prospect for iPhone. If iPhone continues to give up leadership (barely held by adding iPhone 5 stats), the company can be pushed into a spiral like many of its predecessors. Tech is often winner-take-all.

Product line complexity. In November, Apple surprised the market with the launch of iPad mini. For a company that was built on carefully chosen, but small set of options, this is a sort of aberration. For the first time, customers have to decide which type of Apple product to buy. More importantly, different screen sizes are also a source of trouble for app developers, on which Apple primarily relies. The Trouble With Apple's iPad mini - Forbes

Post-Steve Jobs leadership. Since the demise of Steve Jobs, the company's leadership has not given the confidence that they can run a $500 billion company. The failure of Apple maps and the leadership shuffle (the exits of Scott Forstall and John Browett) could be an indication of interior rifts. Microsoft has been going through its internal warlord era since the exit of Bill Gates. Apple executive shakeup: Scott Forstall and John Browett are leaving the company

Weakness in key markets such as India and China. iPhone has always been an also-ran in the world's two biggest mobile markets - India and China. The absence of great support for non-English speakers (Siri is pretty useless if you don't speak English well), high price point has always kept it a small portion in these markets. US and Europe gave them big enough space to grow so far. However, the developed market is already saturated and Apple must find a way to penetrate these two big markets. Samsung and Nokia(!!) lead in these markets. Apple has belatedly started to focus on China, although other BRICs are still not on the radar. While Apple focuses on China, everyone forgot about India | ZDNet

Apple is a great company and in almost all financial metrics, it is stellar. However, there is uncertainty over its future as the leader in the phone industry. Samsung and others have caught up with Apple in mobile technology. It is just a matter of time before more quality apps are developed for Android to tip the network effects advantage. Tech industry is often winner-take-all, and if you are not the one, you are the none.

A decade ago, Nokia, Motorola, and Sony-Ericsson were the leaders. Moto Razr was the hottest selling phone in the US. Sony was the indisputable leader in Consumer Electronics. Where are those companies now? Consumers are very, very fickle and the industry moves on very quickly.

No analyst could survive betting against Mr. Jobs. However, now that Jobs is no more, market is getting bolder betting against Tim Cook. Can he disprove the market?